A recent surge in US Treasury yields is expected to persist, creating volatility in the world’s largest bond market. Investors are demanding more compensation for holding longer-term Treasurys due to the increased risk. The BlackRock Investment Institute weighs in on this development.
Tactical Neutrality, Strategic Underweight
According to a team of investment strategists led by Jean Boivin, the head of the BlackRock Investment Institute, they have taken a tactically neutral stance on long-term Treasurys. Despite high-for-longer policy rates, they remain strategically underweight. While 10-year yields in the US have reached 16-year highs, the strategists believe that the adjustment process is not yet complete.
The State of the Treasury Market
The US Treasury market has experienced a significant selloff since early 2022 when the Federal Reserve began raising interest rates to combat inflation. Consequently, the market is currently in its worst bear market in history. Treasury yields, which move inversely to prices, have risen to levels not seen in 16 years. The unpredictability of the central bank’s rate-hiking path, coupled with positive economic data, has contributed to this rise.
The strategists at BlackRock Investment Institute have maintained an underweight position on longer-term US Treasurys for the past six to twelve months due to their prediction of higher rates based on the economic outlook. However, they are not recommending an overweight position at this time. The team anticipates that investors will demand more compensation, also known as term premium, in exchange for holding long-term bonds. As a result, they continue to be underweight on a long-run, strategic horizon.
Expected Drivers of Higher Yields
Boivin and his team attribute the surge in yields to the repricing of Federal Reserve policy rates since the first rate hike in 2022. With expected policy rates nearing their peak, they believe that rising term premium will be the next driver of higher yields.
The Changing Landscape of Treasury Yields
In late September, an interesting shift occurred in the world of treasury bonds. The term premium of Treasurys, which represents the compensation that investors require for taking on the risk of interest rate fluctuations, turned positive for the first time in almost two years. This change is often influenced by unpredictable factors such as inflation and the Federal Reserve’s approach towards monetary tightening. As a result, long-term yields are predicted to steadily increase as the term premium adjusts to account for macroeconomic volatility, inflation, fiscal deficits, and government debt. BlackRock strategists have even suggested that 10-year yields may reach 5% or higher in the long run.
Current Yield Trends
As of Tuesday, treasury yields are on the verge of reaching their highest levels in 16 years. The yield on the 10-year Treasury note has experienced a 13 basis point increase, settling at 4.850%, while the yield on the 30-year Treasury bond has advanced by 8 basis points to 4.949%. These numbers haven’t been seen since August 2007, according to Dow Jones Market Data.
The driving factors behind future yield jumps and tightening financial conditions are still subject to debate. However, there is one certainty—uncertainty itself. These unknowns are bound to create more volatility in the near future without clear indications of yield movement. Experts suggest that there is now an equal chance of Treasury yields swinging in either direction. This “two-way volatility” is a result of policymakers closely assessing financial conditions, as the potential consequences of rate hikes become more apparent over time.
The Balancing Act
The current landscape brings us closer to a point where the “politics of inflation” will transition into pressure to maintain a steady economic growth by loosening monetary policies. Pressure on the Federal Reserve to combat inflation may soon shift towards promoting favorable economic activity. However, for the moment, analysts anticipate that the Fed will continue to hold tight to its current policies to counteract inflationary pressures.
In conclusion, the world of Treasury yields is experiencing significant transformations. The term premium has shifted, long-term yields are expected to rise, and the market is facing increased volatility. As the future unfolds, the delicate balance between inflation and economic growth will continue to shape the direction of treasury bonds.